Emerging Markets: What Has Changed

(from my colleague Dr. Win Thin)

1) Brazil central bank signaled that its intervention plan will be extended beyond December and into 2014

2) Mexico central bank kept rates steady, as expected, but it sounded a bit more constructive on the economic outlook

3) Thai political uncertainty continues

4) Indian state elections saw the opposition BJP win in key areas, paving the way for a likely BJP general election victory in May

5) The US weighed in on Ukraine, with State Department officials saying it is considering sanctions against the nation after riot police tried to clear protests by force

Over the last week, Mexico (+1%), Peru (+3%), and Turkey (+2%) have outperformed in the EM equity space in local currency terms, while Israel (-3%), China (-2.5%), and Brazil (-2%) have underperformed.

In the EM local currency bond space, China (10-year yield up 9 bp), India (up 6 bp), and Czech Republic (up 5 bp) have underperformed over the last week, while South Africa (10-year yield down 27 bp), Turkey (down 22 bp), and Brazil (down 19 bp) have outperformed.

In the EM FX space, , RON (+1% vs. USD), KRW (+1%) and PLN (+1%) have outperformed over the last week vs. USD, while CLP (-0.6%), PHP (-0.6%), and IDR (-0.5%) have underperformed.

1) Brazil central bank signaled that its intervention plan will be extended beyond December and into 2014. However, Tombini did say that “some adjustments” are possible, with details said to be provided next week. The signal came as USD/BRL approached the 2.40 area. President Rousseff said this week that the currency is at an “adequate” level, which all suggest that the 2.30-2.40 range is preferred for now. Tombini noted that the impact of monetary policy changes happens with delays, which suggests a reluctance to hike rates. However, language from the central bank after the November 50 bp was largely unchanged, suggesting another 50 bp hike in January.

2) Mexico central bank kept rates steady, as expected, but it sounded a bit more constructive on the economic outlook. The change in tone is meant to support its current stance of no more rate cuts, and for now, the economic data support this notion as inflation is creeping higher while manufacturing is showing signs of life. Elsewhere, energy reforms were passed by both the Senate and the lower house. While the plan remains subject to some changes and then needs approval from the states, it appears that the energy sector will get a much needed shot in the arm in terms of foreign investment.

3) Thai political uncertainty continues. After the opposition Democrat Party quit parliament en masse over the weekend, Prime Minister Yingluck dissolved parliament and will call for fresh elections February 2. The problem we have with the opposition’s tactics is that Thaksin and his sister Yingluck were freely elected by indisputable majorities. As such, we would expect Yingluck and her Pheu Thai party to prevail again. We see no reason why the government should give in to opposition demands for a “people’s council” that is not democratically elected. The longer the uncertainty continues, the greater potential negative impact on the economy, which was already softening ahead of the protests.

4) Indian state elections saw the opposition BJP win in key areas, paving the way for a likely BJP general election victory in May. BJP leader Narendra Modi has done a good job as Chief Minister of Gujurat, and is viewed as market-friendly. However, we caution against getting too bullish on a BJP victory next year. Polls suggest any winner will have to rule as part of a coalition, which in the past has thwarted attempts to push through structural reforms. CPI rose a much higher than expected 11.2% y/y vs. 10% consensus and 10.1% in October. We think a rate hike at the RBI meeting December 18 is very likely, though market is expecting no change. IP was weaker than expected in October, -1.8% y/y vs. -1.2% consensus, so the poor fundamental mix should continue to weigh on the rupee.

5) The US weighed in on Ukraine, with State Department officials saying it is considering sanctions against the nation after riot police tried to clear protests by force. The EU also condemned the crackdown. Sanctions would likely prevent an IMF deal from being struck, and would force Ukraine to rely on Russia for help. First Deputy Prime Minister Arbuzov said this week that $10 bln is needed to avoid default. EU officials said today that President Yanukovich has “made it clear that he intends to sign the Association Agreement” with the EU, whose refusal to initially sign it triggered the protests. The situation remains fluid, as it remains to be seen if signing the agreement to deepen ties with the EU will be enough to mollify the protestors. UAH has weakened to levels not seen since late 2012.